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THE SMALL PRINT
The ‘small print’ on my website applies to this article in no small measure due to the fact that, in essence, we are talking about buying property in a foreign country.
Because of the nature of the internet as a medium, and the fact that a lot of the information is from third-party sites such as the federal and provincial governments, it is inherently limited in scope and is subject to change without notice.
Witness the fact that as I write this, the U.S. credit rating has just been downgraded by Standard & Poor’s, for the first time ever.
The sources used for the development of various articles are believed to be reliable, and are checked, where possible, by a professional researcher; however it is entirely possible that errors or omissions can be reproduced unknowingly.
- U.S. Property Status
- Bargains, Risks and Hidden Costs
- Words of Advice
- Some Key Information
- Mortgages for U.S. Properties
- Obtaining a Mortgage in the U.S.
- U.S. Real Estate Recovery
This article was written as a primer, intended for the use of my clients who continue to ask me on a regular basis about purchasing property in the U.S. It should be considered as a starting point for investigation only.
The article is drawn from a number of articles I have written on the topic, all of which remain in their original form on this website,
It is important to note that I am a mortgage specialist and planner operating in B.C. I am not a realtor. I don’t do U.S. property mortgages, and I am not an expert on the topic of U.S. property purchase.
page 2: INTRODUCTION
The following is a primer on a seemingly simple but considerably complicated topic.
I use these words advisedly because, yes, it is very easy indeed for Canadians to purchase property in the United States, but the potential pitfalls and hazards are daunting to say the least, for those who venture forward unprepared, or ill-advised.
Michael Campbell, journalist, TV and radio commentator and economist, predicted recently that the Canadian dollar could well rise to $1.20 US or more within the coming few years.
Warren Buffet has also issued a similar prediction, in a just published article called: “U.S. Dollar to Lose Value in the Long Run.”
This may or may not happen, but if it does, then notwithstanding other factors, the US property market will become even more attractive to Canadians, 1 of 5 of whom according to a recent Leger Poll, are interested in, or actively involved in, purchasing in the U.S.
I addition, the U.S. credit rating has been downgraded as of August 5, by Standard and Poor’s from AAA to AA+.
The Associated Press reported on August 5, that:
“The agency added a negative outlook, warning there was a chance the rating could be downgraded further within two years if progress is not made in cutting the huge government budget gap.
S&P said late Friday the “political brinksmanship” of recent months shows that governance in the country is becoming “less stable, less effective, and less predictable,” raising the risks that one day it might not honor its debt.
And that: Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising US public debt burden in a manner consistent with a ‘AAA’ rating.
S&P is considered the most influential of the three major rating agencies ahead of Moody’s and Fitch; both of which say they continue to review the country’s deficit reduction plan for possible downgrades.”
There has also been a recent call for the removal of the mortgage tax deductibility that Americans now enjoy.
An article on that topic appeared in the Financial Post and the Vancouver Sun on April 4th and said that U.S. realtors are concerned that if mortgage industry rules were changed at this point, it would destroy any hopes of recovery in the sector.
“It is the worst possible time to discuss it because of the fragility of housing,” said Lawrence Yun, chief economist and director of research with the National Association of Realtors.
What is interesting is that no mention of the capital gains side of the equation is being discussed.
Now, in fairness to the experts, it’s really hard to hit a moving target with so many variables at play. However, it’s the overly simplistic answers that worry me.
page 3: U.S. PROPERTY STATUS
I have written a fair bit about U.S. property purchase, and continue to be amazed at the interest in buying property in the United States, and I get at least one question a week on the topic.
I may be very wrong on this one, and it would not be the first time, but I’m not buying into all the hype.
(Now if you want to buy a vacation property, that’s a whole different kettle of fish!)
Home sales in the U.S. have just plummeted, again, but, as usual, we have the “experts” telling us how things are going to pick up in the next 12 to 18 months:
“Things may have bottomed out…”
“All indicators suggest…”
“We know from past experience…”
All of this reminds me of a comment by Richard Nixon, who, when continually being given various analyses by his economists and financial advisors, with caveats such as “On the other hand,” he finally got mad and declared….
“Find me a one-handed economist!”
According to the U.S. Census Bureau, new home sales in the U.S. in February fell by just over 16%. This represents around 225,000 on an annual basis, and is the slowest rate recorded by the Bureau since they began tracking figures in 1963. (That’s a 48-year period!)
They also reported that the median sale price fell 14% from the previous month to $200,000, the lowest value since December 2003.
(Remember that, as always with U.S. figures, different agencies report using very different calculations.
This slide in prices is hurting the economy severely, and while the early stages of 2010 brought some optimism, it that did not last long.
This optimism again resurfaced in early 2011, so we saw a corresponding rise in mortgage rates. However, while raising rates a modest amount and spreading around the feel-good factor, tighter borrowing standards and the continuing, or even worsening lack of jobs, again affected housing demand negatively…. And so, we were back on the merry-go-round again.
Most current sales are of existing homes, and those tend to be mainly (but not all), in distressed areas. New home construction has already fallen dramatically, so much so that without an improvement there will not be sufficient units or homes available in the coming few years.
Now upon reading this you might be forgiven for saying: “Well there is proof that we should buy now.” Well, it would if we knew what was going to happen with the economy, and we don’t, and no one does!
So, consider that Florida alone has well over a million vacant homes, and maybe closer to two million and you begin to see the size of the problem in the U.S. Almost half of Florida mortgage holders are “under water” – a situation in which they cannot recoup the value of their mortgages.
The key is employment and the economy and not housing or housing prices per se.
Of note here is that on the eve of the recent G20, China has begun making pretty serious noises about the U.S. dollar and that there should be other reserve currencies.
This represents their feeling on a reform of the global monetary system and could be considered as the “first round’ in China’s long-awaited view that we must move away from a U.S. dollar-centered global economy. We’ve seen this coming for some time now.
These are sobering thoughts indeed, and I offer them for your consideration if you are thinking of a foray into the U.S. market.
page 4: BARGAINS, RISKS, AND HIDDEN COSTS
Veteran realtors are reminding prospective purchasers never to make a decision based on low price alone.
Buyers should take at least two trips to an area of interest to be able to spot troubled homes and get a feel for the neighbourhood’s schools, beaches, marinas and golf clubs, advises Phil Soper, chief executive of Royal LePage.
That having been said, there may be no better time to go cross-border shopping. Consumer unease over Standard & Poor’s potential downgrading of the AAA credit rating because of rising debt will likely contribute to holding home prices down, says Soper, chief executive of Royal LePage, even as prices fell to new lows in 11 U. S. cities this winter, including overbuilt areas of Florida and Arizona, according to the S&P/Case-Shiller Home Price Index.
Washington, D.C., was the only market where prices rose in January, according to the widely followed index. And market researcher Metrostudy reported the median home price in Florida alone was $121,900 in February, down 53 per cent from June 2006.
Auctions are a popular way for the banks and other creditors to dispose of properties on their books. But auctions aren’t for novice foreign buyers unless they have an experienced local real estate agent working for them. Pre-sale inspections are not allowed.
Soper recommends steering clear of speculative properties. He advises zeroing in on a “living, vibrant, quality community” with lower rates of crime and foreclosure – property that delivers an emotional connection, not necessarily income potential.
By and large a detached and semi-detached home is a safer investment than a condo. Annual condo dues where dues and fees can quickly nullify the rent, and there’s nothing preventing the condo board from levying unforeseen, hefty charges for big-ticket maintenance, such as hurricane upgrades or roof replacement.
A condo’s value can also nosedive as the foreclosure rate for the building edges up, and if there too many foreclosures in a complex it’s difficult for new buyers to even arrange financing.
WORDS OF ADVICE
- American banks generally won’t grant a traditional mortgage unless the buyer has excellent credit and at least a 25-per-cent down-payment. Cash purchases are common for Canadians buying in the U.S. You could also dip into your first home’s value with a home equity line of credit (HELOC) arranged through a Canadian financial institution or mortgage broker.
- Expect to pay a risk premium on home insurance for property that sits empty part of the year. You’ll also pay more for auto and health insurance once you arrive at a holiday home, if you intend to stay long.
- At tax time, Canadians need an individual taxpayer identification number (ITIN) issued by the IRS for property purchases. If you’re planning to rent to holidaymakers or become an absentee landlord, you’ll need to file U.S. income tax, and therefore might benefit from legal advice to explain any beneficial deductions; if you’re buying a house to flip it, there may be ways to maximize credits to reduce capital gains tax. A realtor can inform you of property tax laws, which differ by state and municipality.
- Buying a condo to rent? Make sure board regulations allow this. And be aware that annual property tax and condo fees are typically two per cent of the purchase price.
- Above all, find an experienced U.S. real estate agent either by word-of-mouth or via referral from the U.S. relocation coordinators of national firms such as Re/Max, Century 21 or Royal LePage.
- It is important that she or he have experience in dealing with Canadian purchasers.
page 5: SOME KEY INFORMATION
There is so much information (so called) out there that is just not correct. At the very least, it is not complete.
As mentioned earlier, I am not a realtor, I don’t do U.S. property mortgages, and I am not an expert on the topic of U.S. property purchase.
But I do have a duty of care to my clients.
I have talked to a variety of people, clients and others who have gone through the process.
Most are happy with what they’ve accomplished. However, when I have asked a few simple questions, the response has invariably been: “What? I didn’t know about that. Why was I not given this information?” Etc., etc.
The answer is pretty straight forward . . . Either the persons whom they believe should have offered this information were not aware of it, or perhaps it did not fall within their particular area of expertise.
Once again, competent, professional advice is critical.
It is critical that you obtain this advice before proceeding. And, if it’s free, it’s probably worth exactly what you are paying for it. True independent advice does not come as part of the package from a mortgage broker, bank, or realtor. If it does, take it with a few grains of salt.
There are many factors to consider, including, but not limited to, the following:
- The purpose of the purchase (vacation residence, rental property, long-term investment, etc.)
- Estate tax (U.S. and Canadian)
- Property tax
- Capital gains tax
- Mortgage availability and terms
- How the property is purchased (sole ownership, joint tenancy, corporate purchase, partnership purchase, tenancy in common, Canadian trust purchase)
- The age of the purchasers, (Yes, it’s important), Etc.
Also, please be aware that advisors in the U.S. will almost certainly not be up to date on the Canadian side of the equation. (i.e. How does this purchase affect my Canadian income tax, estate tax, etc?)
The issues you need to discuss with a qualified advisor include:
- Obtaining a Mortgage
- Property Taxes
- Property Rental (Lots of red flags here!)
- Border Crossing
- Estate Tax
- Qualified Domestic Trust (QDOT)
- Canadian Trust
- Joint Tenancy
- Tenancy in Common (TIC)
- Corporate Ownership
A consideration of the above may well deter prospective Canadian purchasers of U.S. property. However, for those who wish to do so, and are willing to carry out careful due diligence, seeking qualified, competent, independent, legal, tax, financial and real estate advice (preferably in Canada), the opportunity to own property in the United States can provide many wonderful benefits.
page 6: MORTAGES FOR U.S. PROPERTIES
As I pointed out earlier, I do not arrange mortgages for property in the Unites States, but, if you wish, I would be pleased to refer you to a number of competent brokers. Brokers an either side of the border will offer referrals when they are confident of the individual or company to whom they provide a referral. This is simply professional courtesy, and I do not receive a referral fee.
While the process of acquiring property in the United States is, in itself, relatively straight forward, there are many things to consider before doing so, and it concerns me greatly to see Canadians rushing into US property purchase, without careful due diligence, just because prices may be low.
Also, please be aware that advisors in the US will almost certainly not be up to date on the Canadian side of the equation.
With respect to all tax and legal issues pertaining to US property purchase by Canadian residents, please be aware that changes in tax laws, court rulings or interpretation, government policy (state and/or federal) or other factors, could alter the information contained in this brief overview.
Such changes have the potential to affect you with respect to future property and tax matters, and possibly on a retroactive basis.
And, if you decide to proceed with financing in the United States I strongly recommend dealing with a mortgage broker who is thoroughly familiar with the process required for obtaining mortgages for Canadian residents, and has done so on numerous occasions.
One of the keys is advice on tax matters which are quite complex, and it would be preferable to seek this advice in Canada.
That having been said, here’s a brief overview distilled from a number of sources including a number of well respected US-based mortgage brokers, lawyers and realtors.
page 7: OBTAINING A MORTGAGE IN THE U.S.
Despite what you may have heard to the contrary, it is possible for Canadian residents to obtain a mortgage in the United States. (Although the financing situation is in a state of flux, and as one US realtor pointed out, they have to deal with changes in the conditions and rules almost monthly.
For a vacation home you will probably need a 30% deposit plus proof of 3 to 6 month’s liquid reserves. You will also need to show a number of previous month’s bank statements, and the lender will contact your Canadian bank to verify all of this.
If the property is being purchased as an investment, you will probably be required to put more than 30% down and show up to 12 month’s reserves.
One viable option is to find a seller who will do the financing, or you may want to consider obtaining a bank loan in Canada, or a second mortgage on your Canadian property.
These can be higher because you are non-resident, Florida is a good example. Also, as a non-resident, you will not qualify for various state exemptions.
You can rent the property, but it is important to be aware of state laws with respect to your responsibilities as a landlord. You will need a property manager, and, most importantly, you cannot do any work on the property yourself. That would be considered the same as working in the United States without the appropriate visa. (You can paint and clean your own property, or unit in a building you own, only if it is never rented, or intended to be rented.)
The penalties for breaking the law on this are very severe. Please read the last sentence again.
As a visitor, you can only stay in the United States for six months (183 days) in any calendar year. When you cross the border and say you’ve got property there, make sure you can present concrete evidence that you do not live there other than on a temporary basis for a vacation.
This is perhaps the most complex area in US property purchase. The tax is calculated on the fair market value of the property, and not on the capital gain accrued.
However, any such tax paid may entitle the taxpayer to a foreign tax credit for Canadian tax purposes. US estate tax can be substantial, especially if it not offset by strong capital gains when the property is sold.
For 2009, US estate tax is applicable to Canadian residents with worldwide assets in excess of US$3.5 million. It has been announced that this will change to US$1.0 million in 2011. However, as with all tax issues, this is subject to change before implementation.
An estate tax credit is allowed, and this is doubled if the property is willed to a Canadian resident
page 8: Estate Tax – continued
There are several methods for limiting or deferring US estate tax, the details and implications of which are well beyond the intent of providing basic information and guidelines here. Methods include:
1. Qualified Domestic Trust (QDOT)
This US trust defers payment of estate tax until the death of the second spouse.
A Canadian trust can purchase and own the property. Upon resale, capital gains are taxable at the rates applicable to individuals; and US estate tax is not levied upon the death of one of the trust’s beneficiaries. Once again, highly competent professional advice is necessary, as there are certain restrictions and disadvantages.
2. Joint Tenancy
This is where each spouse owns 50% of the property – well known and very common for Canadians with property in Canada. With US property owned by Canadians, upon the death of one spouse, the deceased spouse could be declared to be the 100% owner of the property.
Although it is possible to contest this, it is difficult, and the surviving spouse must prove that his or her share of the property was entirely financed by his or her own money and not from funds provided by the deceased spouse. This is not easy to do and the claim can easily be rejected as having insufficient information.
3. Tenancy in Common (TIC)
This method is preferred to joint tenancy, since upon the death of the first spouse, estate tax only applies to his or her share of the property. TIC must be clearly specified in an agreement at the time of purchase.
Under this arrangement two (or more) people co-own a property without a “right of survivorship”. This allows each co-owner to choose who will inherit his/her ownership interest upon death, as compared to joint tenancy which requires that each co-owner’s interest pass to the other co-owner upon death.
4. Corporate Ownership
US corporate tax is higher than in Canada, while capital gains tax is higher in Canada. The use of a corporation is generally not recommended for a number of reasons that include the liability of directors of a private company, in what is, after all, a foreign country for Canadians. (Potential liability considerations are much better handled through an insurance policy.)
And, for those who wish to be co-owners, and who plan to occupy some or all of the co-owned property, the legal and tax disadvantages created by a corporation generally outweigh any potential benefits. It is also more expensive with various yearly fees and corporate filings.
A consideration of the above may well deter prospective Canadian purchasers of US property. However, for those who wish to do so, and are willing to carry out careful due diligence, seeking qualified, independent, legal, tax, financial and real estate advice, the opportunity to own property in the United States can provide many benefits.
page 9: U.S. PRICES COMPARED to OTHER COUNTRIES
The subject of house prices is one that I confront every week in relation to mortgage planning.
There are so many variables to consider when choosing a mortgage. Mostly its interest rates and where they are headed, so that an informed decision can be made as to the type of mortgage.
But, in many situations, the direction of house prices over a certain period of time is a major factor.
Problem is that I can’t find my crystal ball. I had it last week but I don’t know where it’s gone!
Who was it that said an economist is a person who comes on TV this week to explain why the predictions he or she made last week were not correct?
To step back for a minute and try to get a handle on the future of house prices requires a solid understanding of the economy. You can go to school for four to six years to learn this, but as we have seen with the recent housing / mortgage debacle, particularly in the United States and in many (most) other countries, the best minds got it wrong.
(We didn’t foresee that…. We didn’t expect…. No one could have foreseen that….. Etc.)
For me to comment seems trite at best, so I look to “trusted” sources for my information and always add a liberal amount of salt.
The Economist is one of my favourite sources, particularly because everything they do is done “on the ground” with correspondents in every corner of the globe.
Their recent take on house prices over the past year is interesting. As always, they take a global view considering twenty-one countries in a recent article.
page 10: PRICES – SOME SPECIFIC FIGURES
Here’s a quick summary then, with some extra comments by me:
- Of the 21 markets covered, 17 show an increase
- Asia’s prices show the most growth with Singapore, Hong Kong and Australia on top
- Canada is roughly in the middle of the group
- Ireland is at the bottom
Here are a few of the numbers for comparison purposes indicating the % change over the last 12 months, over the last 13 years, and the under/overvalued amounts today:
|Country||Change||1997-2010||Under / Overvalued *|
What do these numbers say about the value of Canadian houses?
Bearing in mind that prices have come down somewhat of late, the figures suggest that our market is overvalued by 23.9%. They also show an increase of 4.5% over the last year, and an overall gain of 70% from 1997 to 2010.
So, how should this information affect your buying or selling decision? Crystal ball please…. This brings us back to a discussion of the numerous variables at play here.
The classic answer for awhile now has been that yes, the market may be overvalued and prices may come down (they are), but interest rates are going up (they are), so you should not hold off on buying. There seems to be 100% agreement that rates will continue to rise.
Not included in the chart above is the familiar split between the core countries and peripheral ones of Europe, with Ireland, Spain and Italy continuing to show declines, while Germany and France show strong gains in value over the past year, and England is still overvalued.
One can argue with a good degree of confidence, that contradictory figures notwithstanding, the United States is more or less fairly valued right now.
However, I would be very wary of purchasing in the U.S. without a considerable degree of due diligence as to the possibilities for the future.
Finally, look at the figures for Switzerland. Modest growth with a slight undervaluation. How is it that the Swiss seem to get it right so often?
* Valuation determined by a comparison of the current ratio of house prices to rents against its long-run average.
** You can argue the case for the US either way because of the way the figures are reported.
One index, that of the Federal Housing Finance Agency,, the regulator and conservator of 12 Federal Home Loan Banks, excludes houses financed with large mortgages; while the Standard & Poor’s, Case-Shiller index reports on a variety of markets within the country including, composite, 10-city, 20-city, and individual metro areas.
Put all of these together and the figures are close to being a wash. Or, you can pick an index to support a particular view. (Showing that once again, you can prove anything with statistics!)
page 11: U.S. REAL ESTATE RECOVERY?
The following is taken from a newsletter written for by Chris Butterworth in Phoenix, Arizona. Chris granted his permission for the use of the article. You can contact Chris and Heather Barr at Thompson’s Realty where they cover the Greater Phoenix area.
Their excellent newsletter is available at: http://ThePhoenixAgents.com.
Let’s look at supply and demand, and compare where we are today with where we’ve been over the last decade. How long do homes stay on the market before they sell?
If we disregard the short-time highs in 2005, and lows of 2007-2008, and compare today with 2001 and 2002 (back when things were “normal”), we find that we’re at about 90 days on the market, compared with 50-60 days earlier in the decade. That’s 50%-80% worse than “normal”, which means we still have a long way to go.
The interesting thing is the pattern looks exactly the same across all price ranges. A review of each price range (less than $150,000 to over $600,000) shows significantly longer marketing times. The only way this will change is if we have a smaller supply, fewer foreclosures or, a larger demand.
Distressed listings have contributed greatly to the current supply. These include any type of bank-involvement, including short sales, pre-foreclosures and REOs, (Real Estate Owned – property that has not sold at a foreclosure auction, and now owned by a bank or other lender).
Short sales are where proceeds fall short of the balance owed on the property’s loan. It often occurs when a borrower cannot pay the mortgage on the property, but the lender decides that selling the property at a moderate loss is better than pressing the debtor.
Both parties consent to the short sale process, because it allows them to avoid foreclosure, which involves hefty fees for the bank and a poorer credit report for the borrower.
Pre-foreclosures are properties available in the period between the mortgage lender’s notice to the borrowers of their default on the mortgage payments, and the auction sale event that finalizes the transfer of title to the property to the lender.
REO (Real Estate Owned). A bank will typically set the opening bid at a foreclosure auction for at least the outstanding loan amount. If there are no bidders the bank will legally repossess the property. It is then listed on their books as REO – Real Estate Owned – and is categorized as a non-performing asset. These REO listings make up about 40%-50% of the total number of distressed properties.
It can be over a year from the time a home owner first explores a short sale until the bank completes the foreclosure process and gets the home on the market as bank-owned.
We also know that very few of the short sale listings actually get sold and closed before going into foreclosure.
This means that about half of the distressed listings will hit the market again sometime in the next year or so as a bank-owned REO listing. So even if the economy in general, and the employment numbers in specific, gets back on track, we’ve still got a pipeline full of foreclosures heading our way.
This tells us there will not be a dramatic reduction in the supply side.
There is no reason to expect demand from first-time buyers will increase anytime soon. At best it will bump along at a similar rate. At worst it will fall sharply.
The same holds true for investors; those who wanted (and were able) to take advantage of lower prices have already done so. Some are being more cautious, waiting to see how the pending problems in commercial real estate will impact the residential market.
There will still be good deals in the coming few years and there will still be investors buying homes. But it would be difficult to support the argument that investors are going to drive demand enough to drastically change the supply and demand balance.
“The market starts recovering in earnest when bank-owned REOs stop hitting in waves. This will happen about a year after employment stabilizes.”
Finally, please see also my March 18, 2011 article for a broader perspective on the future of property values in general at: The Future of Property Values.
Golf or tennis in Arizona in the middle of winter anyone?
Above all, enjoy your U.S. purchase adventure!
(Copyright Dara Fahy. All rights reserved.)